Is the Market Rising Due to Inflation?

Is the Market Rising Due to Inflation?

With the Fed’s announcement that it’s increasing interest rates, it seems likely that inflation is going to be a concern for investors in the near future. Much of this is fairly predictable, as the policies put forward by the new administration typically lead to inflationary pressures.

Historically, tax cuts put more money into the economy, and big military and infrastructure projects put pressure on finite resources and labor. Similarly, isolationist policies and tariffs typically increase the price of goods. All this puts pressure on traditional stocks and shares.

However, a closer look at what’s spurring on the markets reveals that the driver isn’t necessarily the increased risk of inflation. Instead, it might be tied to risks of deflation. 

Inflation Caps and Floors

Part of this is seen with trading inflation caps and floors. Simply put, these derivatives let traders make bets on the consumer price index, or CPI. Caps are profitable when inflation averages higher than the strike price; floors are profitable when CPI is lower than the strike price. Currently, the risk of high inflation — anything over 3 percent — has risen slightly. The corresponding risk of deflation or low inflation — anything under 1 percent — has risen much faster.

The chance of a large change in value of the S&P 500 is considered extremely low. The chance of a 20 percent movement upward is approximately 10 percent, and the chance of a 20 percent movement downward is hovering around 9 percent, according to Minneapolis Fed data.

All of this points more towards stability and a potential plateau where prices don’t change that much. This ensures that growth is more likely to increase gently in line with inflation, creating a more stable market.

However, these pressures also limit the likelihood of reasonable gains from stocks and shares, which is why people move into commodities such as gold. In some cases, you might choose a gold-backed ETF that focuses on companies that trade and mine gold, but even that is likely to have the same limitations seen by standard stocks and shares.

Why Buy Gold?

This is why it’s wise to consider investing in the commodity itself. Gold provides a solid hedge against inflation, and if inflation does exceed 3 percent, gold goes up correspondingly.

Naturally, it’s always wise to have a variety of hedges in your portfolio, as a well-balanced portfolio can adjust to sudden market shocks, no matter how expected or unexpected. Buying gold now helps you keep your portfolio safer in the long run.

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